Mativ Holdings, Inc. (MATV) Q2 2015 Earnings Report, Transcript and Summary

Good morning. My name is Erica and I will be your conference operator today. At this time, I would like to welcome everyone to the Neenah Paper Second Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ prepared remarks there will be a question-and-answer session. [Operator Instructions]. As a reminder, ladies and gentlemen, this conference is being recorded today, August 6, 2015. Thank you. I would now like to turn the conference over to Mr. Bill McCarthy, Vice President, Financial Analysis and Investor Relations. Please go ahead, Mr. McCarthy.

Okay, thank you and good morning, everyone. Our press release announcing second quarter earnings went out yesterday afternoon and in our call today, John O'Donnell, our Chief Executive Officer; and Bonnie Lind, our Chief Financial Officer will review activities and results for the quarter in detail and in addition, we will discuss our recent acquisition of FiberMark. As usual, following our prepared remarks we will open up the call for questions. I'll start with a few summary comments before turning things over to John and Bonnie. Neenah reported record bottom line results this quarter with earnings per share of $0.97, operating income of $28 million and free cash flow of $33 million. With benefits of lower input costs, we continue to offset negative impacts from currency translation on the bottom line although the weaker euro continues to impact our top line. Consequently, while reported sales for the quarter of $224 million were down 3% from a year ago, on a constant currency basis, they were actually up 4%, including a boost from our filtration acquisition last year. While there have been no adjusting items in 2015, at times, we will use adjusted figures to aid in comparability between periods. Last year, adjusted earnings excluded technical products related acquisition and restructuring costs of approximately $700,000 or $0.02 per share. These adjustments and non-GAAP measures are reconciled to corresponding GAAP figures in our press release. Finally, I'll remind everyone that our comments today may include forward-looking statements. Risks and uncertainties that could cause actual results to differ from these statements are outlined in our SEC filings and in the Safe Harbor disclaimer on our website. And with that, I will turn things over to John.

Thank you and good morning. As Bill mentioned, our team has delivered record results for second consecutive quarter. In addition to impressive top line growth in technical products, both businesses sold a more profitable mix and benefited from lower input costs and higher selling prices. This performance reflects the success of our strategies to grow in defensible, profitable niches and was even more impressive since it happened at the same time our teams were completing a thorough diligence and acquisition of FiberMark. I'll cover more about the acquisition later in the call. So let me start, as usual, with a review of some of our key strategies and initiatives. First, we'll continue to enhance our leading positions in high-value categories that are core to Neenah. These categories include premium fine papers and in technical products, filter media and performance backings. I'll start with fine paper and packaging. This is a business that continues to deliver steady results with sales of around $100 million a quarter and attractive financial returns. With our well-known brands, high-quality papers and marketing expertise, we are market leaders with an enviable record of outperforming the market. While second quarter sales fell off from last year's all-time high, our record bottom line was preserved. Commercial print brands sold through wholesale distribution remained healthy and retail sales, which represent about 20% of fine paper and packaging, are doing very well, up 8% this year. We sell our consumer brands through leading retailers like Wal-Mart, Office Depot, Staples and Amazon. A second core category is performance backings. These technical products include specialty tapes and abrasives, where we add value through our saturating and coating expertise to provide specialized features such as high temperature resistance, fine paint lines and UV protection. These markets grow in line with global GDP and customers are supported out of our manufacturing facilities in both the United States and Germany. The stronger US dollar this year has resulted in some challenges, however. With our global footprint, we are pursuing opportunities to maintain or grow share while also expanding into adjacent markets. The FiberMark acquisition will support these growth plans with their significant breadth of value-added coating, saturating and finishing capabilities. Transportation filtration is a third category and we're excited as we execute plans to increase our global presence. Sales in euros grew 12% in the second quarter, reflecting continued success in Europe and significant growth in exports, which included a 36% increase in sales in the United States. Our project to increase capacity in the United States through the capital-efficient conversion of a fine paper asset is proceeding on track and customers are responding positively to our commitment to increase our presence in the Americas. We expect to start up commercial production in early 2017 and we are already optimizing and rebalancing operations to ensure a seamless transition for our customers in both fine paper and filtration. A second strategic priority is to increase our size and diversification through targeted growth efforts in profitable and defensible product platforms. Targeted areas include luxury packaging, specialty filtration and other performance-oriented products. In addition to allocating internal resources to grow organically in these markets, we've focused acquisition efforts here as well. Last year, we had the Crane filtration acquisition and this year, with its highly regarded premium packaging capabilities and overlapping technical products, FiberMark is another great example of how we target M&A to enhance the scope and speed of our growth in targeted areas. Finally, we're always committed to delivering attractive returns to our shareholders, inclusive of a meaningful cash component. Our strategic decisions are anchored by our commitment to maintaining an attractive return on capital while we execute our growth strategies. We believe doing this effectively separates Neenah from other investment options and will ultimately be reflected in an increasing stock price. We've been pleased with the returns our shareholders have received, as well as the positive reception to the FiberMark announcement. Our strong balance sheet and operating cash flows will allow us to continue to make these value-adding investments while supporting a meaningful dividend. Before I turn the call over to Bonnie, I'd like to recognize our teams for the extra efforts they invested to deliver the record results this quarter, all the while executing against these important strategic initiatives. Bonnie.

Thanks, John. Our results were driven by terrific bottom line performance in each of our segments. I will begin with technical products. Sales of $119 million were up from $117 million last year despite a $15 million reduction due to currency translation. We were able to offset this with the addition of our specialty filtration business acquired in July 2014 and also an impressive 4% organic growth rate in constant currency. The increase in organic sales was led by volume-based increases in transportation, filtration and labels, as well as improved selling prices and a higher value mix, partly offset by weaker results in backings. Operating income was $15 million, up 12%, compared to adjusted income of $14 million last year. Negative currency impacts were more than offset by higher volumes, improved net selling prices and lower input costs. Turning to fine paper and packaging, sales in the quarter were $98 million, down 8% compared with a record $107 million last year, but more in line with our typical run rate. While retail and premium packaging continue to do well, commercial print sales were impacted by lower sales at a large consolidating customer and reductions in non-branded volume. As expected, non-branded volume has been more competitive this year with prices influenced by lower commodity pulp prices. Since this tends to be lower margin volume, the impact to the bottom line was minimal. Consequently, operating income of more than $17 million was equal to last year's near record level. The impact from lower volume was fully offset by a more profitable mix, higher net prices and lower input costs. Consolidated SG&A was $20.8 million, in line with $20.4 million last year and unallocated corporate costs of $4.8 million were also in line with last year. Net interest expense of $2.8 million decreased slightly from $2.9 million last year. As of June 30, debt consisted of $175 million of bonds and $40 million of additional borrowings primarily through our global revolving credit facility. This facility had available capacity of $125 million as of June 30 and we borrowed $43 million against it to finance the FiberMark acquisition. With a variable interest rate currently less than 2%, this will result in added annual interest expense of around $1 million. Our effective tax rate in the quarter was 33%, down from 35% last year and also below the 37% rate we indicated earlier in the year. Our year-to-date rate of 35% reflects a federal manufacturing deduction available to us following consumption of our net operating losses. Our cash tax rate of 20% to 25% is below book expense, helped by prior-year R&D credits that we expect to consume over the next two to three years. As a reminder, we expect to qualify for additional credits of over $1 million each year, but can't book these unless Congress renews the law each year. While our cash tax position is favorable, tax payments are higher than past years and we have been able to offset this with significantly lower pension contributions as a result of past actions taken to manage our pension plans. Currently, the US plan is fully funded and we expect to contribute really minimal amounts in the near term. Let me finish with a few comments on cash flow and deployment. In the second quarter, cash from ops was almost $40 million, up from $37 million in 2014, with the increase primarily due to our higher earnings. Capital spending of $7 million increased from $5 million last year as we began spending on the filtration expansion project. The bulk of spending for this project in 2015 will occur in the second half, as planned and full year spending, including FiberMark, is expected to be approximately $50 million to $55 million, which is on the upper end of our targeted 3% to 5% range. Our strategy is to utilize multiple avenues in deploying capital to add value. I am pleased to note that with organic spending on filtration capacity, the recent FiberMark acquisition and an increasing dividend, we're doing just that. I'll turn things over to you, John, now to talk about our outlook for the second half and more details on FiberMark.

Thanks, Bonnie. A stronger U.S. dollar remains a factor for us and others. At around $1.10, the euro is roughly 20% below last year's rate of $1.37 and continues to significantly impact year-on-year sales comparisons. In the first half, currency translation reduced our top line 7%, or around $30 million. As we've said, every $0.10 change in the euro impacts our top line by $25 million a year. We're offsetting currency impacts on the bottom line helped by lower input costs since commodities like energy and pulp tend to move inversely with the U.S. dollar. Input costs are about $7 million lower year to date with half of this due to a spike in energy costs in the first quarter of 2014. Full-year costs are projected to be around $10 million below 2014, but input costs in the second half are expected to increase around $2 million versus the first half. From a top line perspective, technical product second half sales are historically 8% to 10% below the first half due to seasonality, exaggerated this year by currency. Bottom line impacts reflect these lower sales and reduced operating schedules, including annual maintenance downs in both businesses. Maintenance downs occur in the third quarter and represent an added cost of around $4 million. Since our German filtration outage occurred in the fourth quarter last year to accommodate a project to increase filtration capacity, the year-on-year difference in the third quarter will be around $1 million higher in 2015 due to timing. Effective August 1, we will include FiberMark in our results and I'm pleased now to share more about this acquisition with you. As I mentioned earlier, strategically, this is a great fit with Neenah. FiberMark is well regarded in the marketplace and known for their high-quality products and service. They serve premium niches, many of which nicely complement existing markets we've targeted for growth. I'm a firm believer that we add more value to the product, the farther we are from the trees and FiberMark brings a wide array of downstream coating and finishing capabilities. These technologies combined with Neenah's marketing expertise and customer access will fuel our growth strategies for the future. In round numbers, the $160 million of additional sales will be split roughly equally between fine paper and packaging and technical products. In fine paper and packaging, we are significantly increasing our presence in growing markets like luxury packaging and wide format papers while also adding products such as filing and office products, which are profitable, but in mature markets. FiberMark's packaging portfolio includes premium folding cartons, curved edge wrapping and other unique products that complement our strong offering in labels. Like Neenah, FiberMark serves niche markets best described as high-value items in small packages. In addition to verticals we are in today, such as electronics, spirits and cosmetics, FiberMark sells into categories new to Neenah. This expanded access increases our addressable market size by 50% to $450 million and our combined share of less than 15% provides us with plenty of room for growth. In technical products, many of FiberMark's categories overlap ours, including tape, labels, decorative coverings, security, specialty papers. Their wide range of finishing coating assets can uniquely satisfy customer needs while providing a new base for growth and the opportunity to combine and leverage capabilities. FiberMark has six facilities in the US and one site in the UK. As I've mentioned, their operations are heavily skewed to coating and finishing, not paper manufacturing. We are pleased to see that their operations are well-maintained and well-capitalized with available capacity for future growth. Incremental ongoing capital spending is expected to be well within the target of 3% to 5% of sales.

We've owned FiberMark for three business days so far and are still completing purchase accounting and other activities, but I would like to share some historical numbers with you. Currently, FiberMark has EBITDA of around $18 million with $10 million of depreciation and amortization. This represents operating income of around $8 million, or about $0.25 per share of annual accretion. Like us, FiberMark has seasonality with second half sales 8% to 10% below the first half and they also schedule annual maintenance downs in the third quarter. So for the remainder of this year, incremental sales are expected to be in the range of $10 million to $15 million per month with lower than average margins due to seasonality and maintenance downs. We have communicated expected one-time costs of up to $5 million in 2015 for integrations and other costs related to the acquisition. So as normal with any acquisition, there will be a lot of moving parts in the next five months. As we move forward, we are targeting to reach $6 million of annual synergies by the end of year three. Any synergies this year are likely to be nominal, but would ramp up to $2 million to $3 million next year and the full amount in 2017. Synergies come from a number of areas, including internalizing product at both companies that currently outsource, purchasing scale benefits and efficiencies in areas such as manufacturing loadings and SG&A. In addition to the strong strategic fit and added capabilities for growth that John mentioned, the acquisition will provide important synergies and an attractive use of capital with a mid-teen rate of return and annual accretion of more than $0.40 per share. So John, I'll turn it back to you to wrap up.

Thanks, Bonnie. One characteristic of a strong organization is its ability to execute on multiple fronts. I think you've seen our teams do that, delivering record results at each of the past two quarters while moving forward with strategic priorities like our North American filtration expansion and the acquisition of FiberMark. While we know that an acquisition in the early stages can be distracting and result in uncertainty to employees and customers, we also know that it is during this integration effort where value is realized or lost. This is our fourth acquisition in the past four years and I'm confident with the team's integration planning and execution abilities. Most importantly, however, is for our employees who are not directly involved in the integration to continue to deliver on our track record of solid results in our existing businesses. It's an exciting time at Neenah as we build a leading global specialty materials company. We're in strong financial shape, well-positioned to act on opportunities that create value for our shareholders. Thank you for your interest in Neenah today and at this point, I'd like to open up the call to questions.

Most certainly. [Operator Instructions]. Okay and your first question comes from the line of Dan Jacome.

Hi, Dan.

Dan?

Some branded paper volume issues at a large customer, I'm assuming that’s Veritiv Unisource, is that correct?

Yes, that is correct.

Okay, is this a one-off or what are your comfort levels with this as we head into the back half?

Well, we've had a great relationship with Veritiv over the years. We continue to find opportunities to grow together. Any companies coming together are going to find integration opportunities and obviously, since our products are predominantly branded and have the inventory, there's going to be one-time impacts for them. I feel very, very comfortable both in our relationship, their position in the marketplace and the importance of our brands out there. So I can't necessarily say it's going to last another quarter or not, but my expectation is they're successfully working through their integration efforts and we should be doing very well. It's probably hard when the fact that we are comparing ourselves to a record 2014 with this [ph], but, yes.

Okay, good. Appreciate that. And then I guess turning to transportation papers, I noticed that Ford and the auto guys in July continue to impress, especially the F-series. I'm just wondering if you are seeing this in your business. And then with these spectacular numbers, do you still see a sustainable runway for the U.S. auto industry and how it relates to your business as we start thinking about the 2017 ramp in Appleton? Thanks.

Yes, absolutely. I think -- so you highlight the fact we do have the Cavalier [ph] and the F-150. And as we've said in the past, our business really isn't tied solely to new car sales. So it's both new cars and the aftermarket, as well, it’s really tied to miles from that standpoint. Love when the automotive industry picks up and driving that, but we've seen over the past 11 years I think we're at now a steady 8% growth and we know we've went through a variety of new car and aftermarket. So I feel very, very strong about our growth trend. I'm most encouraged by the 36% increase in the U.S. I think that's a great testimony and illustration of the reception that our new capacity addition is getting from the customers here in the United States and South America.

Got you. Okay, appreciate it. Thanks a lot.

Our next question comes from the line of Steve Chercover from DA Davidson.

Hi, Steve.

Good morning, everyone. I apologize. I got on a little bit late. But I just wanted to ask about FiberMark. You said $0.40 run rate of accretion. Is that something that we can expect in 2016, or do we have to wait till the full $6 million in synergies are attained?

That's the full $6 million of synergies, so that more ties out to the $24 million of EBITDA.

So it's a '17 expectation, 2017 expectation.

Right. So the $2 million to $3 million, Steve, is what we would expect in 2016 of synergies.

$2 million to $3 million synergies in 2016. Got it. And will you call out the $5 million that you spend in 2015 to integrate as extraordinary items?

Yes, we will.

Okay, so that will be stripped out of operating numbers. Okay. And then so we understand where the pressure on the paper side came from, from a volume standpoint. Once that's done, do you think their run rate will be equivalent just with a different footprint?

Yes, on the paper side, I really would say that's a tale of two cities. So we talked about the consolidating customer and I do believe that has a time limit and getting back to their run rate. The other is that, as input costs decline, lower value or lower margin items are -- that volume is at risk as people kind of snag the low ends of making items. So I think that's best evident when you look at an 8% reduction on a top line, but we retain the bottom line. So those are more base load, help fill our assets. So we manage our costs a little differently during times of lower input costs, but those are the two I think. They probably -- I'd say half-and-half has been the cause for the decline.

Got it. And sorry going back to FiberMark, and I'll turn it over, you said it complements your investments both in your specialty packaging and filtration. For modeling purposes, should we be putting this in the fine papers business? That's how I…

Steve, if I said anything about filtration, I misspoke in there. It really would be specialty packaging and wide format and that will be in the fine paper side, about half of the volume overall. And as a reminder, they picked up two growth categories -- again, luxury packaging, wide format -- and they also picked up a mature filing business. So in our fine paper side of the business, I would say they've always had an expectation or aspiration to mitigate any of the overall declines. That really doesn't change there. It provides them with lots of capability for future growth in driving and getting a greater share in that $450 million luxury packaging. On the technical side, the other half, which is going to be on the technical products side, more in our performance-oriented products, those are going to grow about global GDP. So it will mirror what I think we've demonstrated historically in that side of the business.

All right, so actually for modeling, we should sprinkle it kind of 50-50 into your two current segments?

Yes, sir.

Got it. Okay, thank you.

Your next question comes from the line of Jon Tanwanteng from CJS Securities.

Good morning, guys and congrats on the quarter and closing the acquisition. Can you just clarify the accretion that you talked about? In the press release, when you announced the FiberMark acquisition, you said $0.40 a share. Is that including the synergies and is that on a 2017 basis, or do you expect that just next year?

Yes, that's a 2017 number with the synergies.

Okay.

And it’s net of the interest, but with the synergies.

Okay. What's the 2015 or ‘16 number, if you could provide that?

Yeah, ‘16 will have about $2 million to $3 million from the overall synergies. I think 2015 is nominal.

Okay. And that's all the accretion, right?

Yes, I think we said $0.25 would be the accretion that you get from acquiring the base business, $8 million of EBITDA on an annual basis and then we would expect that the back half, the revenues 8% to 10% lower, like ours and the margins are likely to be 200 basis points lower in the back half than the front half, also like us, due to the timing of the maintenance downs and the other seasonal downtime.

Great. That's helpful. And then could you just update us on the return of value to shareholders, from a dividend or share buyback standpoint, or further M&A just given that you did just complete an acquisition, but you still have pretty good cash on the balance sheet?

From an M&A standpoint, let’s catch our breath. But I think as you see from our balance sheet [Technical Difficulty] that’s still resident out there. We [Technical Difficulty] is that helpful?

John, I think you had -- I don't know if it was my phone or yours, but I actually lost the entire response. We can follow that up offline.

Okay, well, I'll give you the quick summary and it really is our priorities for uses of cash have not changed dramatically. We are still in the position where if an opportunity for M&A comes up, we can act upon it, if we need to. And from our standpoint, any debt that we have taken on has been pre-payable. So opportunity to continue to reduce that. We are still committed as a company to a meaningful dividend as we've demonstrated this year with our dividend increase. And then we do have a share repurchase authorization of $25 million, which we've used minimally so far, but still an option.

Okay, great. Thank you very much.

There are no further questions at this time. I would now like to turn the floor back to Mr. McCarthy for closing remarks.

Great. Well, on behalf of John, Bonnie and the entire Neenah team, I'd like to thank you all for your interest today and we'll look forward to updating you on our progress on our next call in November.

Ladies and gentlemen, that does conclude today's conference call. You may now disconnect.